BSAD 221
Introductory Financial
Accounting
Donna Gunn, CA
Income Statements
Service Company
Royal LePage Real Estate
Income Statement
Year Ended December 31, 2012
Service revenue
$
XXX
Expenses
Operating and
administrative expense
X
Depreciation expense
X
Income tax expense
X
Net income
$
X
Merchandising Company
Leon’s Furniture Ltd.
Income Statement
Year Ended December 31, 2012
Revenue
$ 703.2
Cost of goods sold
419.8
Gross profit
283.4
Operating expenses:
Operating and
administrative expense
X
Depreciation expense
X
Income tax expense $
X
Net income
$
56.9
Balance Sheets
Service Company
Royal Lepage Real
Estate
Balance Sheet
December 31, 2012
Current assets:
Cash
$
X
Short-term investments
X
Accounts receivable, net
X
Prepaid expenses
X
Merchandising Company
Leon’s Furniture Ltd.
Balance Sheet
December 31, 2012
Current assets:
Cash
$
Short-term investments
Accounts receivable, net
Inventory
Prepaid expenses
X
X
X
84
X
Accounting for Inventory
Balance Sheet
Cost of inventory on hand
= Inventory (Asset on balance sheet)
Inventory =
Number of units on hand × unit cost
Accounting for Inventory
Income Statement
Cost of Inventory that’s been sold
= Cost of Goods Sold
(Expense on income statement)
Cost of goods sold
= Number of units sold × unit cost
Costs Included in Inventory
Purchases
The cost principle requires that inventory be recorded
at the price paid or the consideration given.
Include all costs incurred to bring the asset to useable
or saleable condition.
Invoice
Price
Freight
Inspection
Costs
Preparation
Costs
Flow of Inventory Costs
Merchandiser
Merchandise
Purchases
Merchandise
Inventory
Cost of
Goods Sold
Manufacturer
Raw
Materials
Direct
Labor
Factory
Overhead
Raw Materials
Inventory
Work in Process
Inventory
Finished Goods
Inventory
Cost of
Goods Sold
Comparing Merchandising and
Manufacturing Activities
Merchandisers . . .
• Buy finished goods.
• Sell finished goods.
Manufacturers . . .
• Buy raw materials.
• Produce and sell finished
goods.
Nature of Cost of Goods Sold
Beginning
Inventory
Purchases
for the Period
Goods available
for Sale
Ending Inventory
Cost of Goods Sold
(Balance Sheet)
(Income Statement)
Beginning inventory + Purchases = Goods Available for Sale
Goods Available for Sale – Ending inventory = Cost of goods sold
Perpetual and
Periodic Inventory Systems
Provides up-to-date
inventory records.
Perpetual
System
Provides up-to-date
cost of sales records.
In a periodic inventory system, ending inventory and cost
of goods sold are determined at the end of the accounting
period based on a physical count.
Recording Transactions
in the Perpetual System
Dr. Cash or Accounts Receivable
Cr. Sales Revenue
To record sales revenue
Dr. Cost of Goods Sold
Cr. Inventory
To record COGS
Recording Transactions
in the Perpetual System
Purchase price of the inventory
+ Freight-in
$570,000
4,000
– Purchase discounts
– 14,000
= Net purchases of inventory
$560,000
Recording Transactions
Inventory
560,000
Accounts Payable
Purchased inventory on account
Inventory
Beg.100,000
560,000
560,000
Accounts Payable
560,000
Recording Transactions
and the T-Accounts
Sale on account $900,000 (cost $540,000):
Accounts Receivable
Sales Revenue
Cost of Goods Sold
Inventory
900,000
900,000
540,000
540,000
Recording Transactions
Cost of Goods Sold
Inventory
Inventory
Beg.100,000 540,000
560,000
120,000
540,000
540,000
Cost of Goods Sold
540,000
Reporting in the
Financial Statements
Income Statement (partial)
Sales revenue
$900,000
Cost of goods sold
540,000
Gross margin
$360,000
Ending Balance Sheet (partial)
Current assets:
Cash
$ XXX
Short-term investments
XXX
Accounts receivable, net
XXX
Inventory
120,000
Inventory Costing Methods
Specific
Identification
FIFO
Weighted
Average
Specific Identification
When units are
sold, the
specific cost of
the unit sold is
added to cost of
goods sold.
First-In, First-Out Method
Oldest Costs
Cost of
Goods Sold
Recent Costs
Ending
Inventory
Weighted-Average Cost Method
When a unit is sold, the average cost of each unit in
inventory is assigned to cost of goods sold.
Weighted-average cost (WAC) per unit:
Cost of goods available for sale
Number of units available for sale
Ending Inventory = Ending Units x WAC per Unit
Cost of Good Sold = Units Sold x WAC per Unit
Illustration of Costing
Leon’s began the period with 10 lamps costing $10 each;
During the period, Leon’s bought 50 more lamps sold 40
lamps, and ended the period with 20 lamps.
Inventory
Beginning bal.
(10 units @ $10)
$100
Purchases:
Cost of goods sold: (40 units @ $?)
No. 1
(25 units @ $14)
$350
No. 2
(25 units @ $18)
450
Ending bal.
(20 units @ $?)
?
Illustration of Costing
The big accounting questions are:
1. What is the cost of goods sold for the income
statement?
2. What is the cost of the ending inventory for the
balance sheet?
Illustration of Costing
Total Dollar Amount of Goods
Available for Sale
Inventory
Costing Method
Ending Inventory
Cost of Goods Sold
Weighted-Average
$900 total cost ÷ 60 units = $15/unit
Cost of goods sold = 40 × $15 = $600
Ending inventory = 20 × $15 = $300
First-In, First-Out
Beginning
(10 units @ $10)
Purchase No. 1 (25 units @ $14)
Purchase No. 2 (25 units @ $18)
$100
350
450
40 units sold and 20 still on hand
Ending inventory cost
= 20 units × $18 per unit
= $360
Assume inventory on hand are from most recent purchase at $18
per unit
First-In, First-Out
Beginning
(10 units @ $10)
Purchase No. 1 (25 units @ $14)
Purchase No. 2 (25 units @ $18)
$100
350
450
40 units sold and 20 still on hand
Cost of Goods Sold
= 10 units x $10 +25 units x $14 + 5 units x $8
= $540
Assume inventory sold was the inventory purchased
first
Changing Costs
When inventory costs are increasing:
Weighted Average cost of goods sold is highest
because it is based on the average of the costs for
the period, so includes the new higher costs.
FIFO cost of goods sold is lowest because it is
based on the oldest costs and ignores the most
recent costs.
Financial Statement Effects
of Costing Methods
Advantages of Methods
First-In,
First-Out
Weighted
Average
Ending inventory
approximates
current
replacement cost.
Smoothes out
price changes.
Accounting Standards and
Inventories
Comparability
(including consistency)
Disclosure
Accounting Principles and
Inventory
Comparability states that businesses should
use the same accounting methods and
procedures from period to period.
Disclosure Principle holds that a company’s
financial statements should report enough
information for outsiders to make informed
decisions about the company.
Lower of Cost or
Net Realizable Value
Ending inventory is reported at the lower of cost
or net realizable value (LCNRV).
Net Realizable Value =
The expected sales price less selling costs
Estimating Inventory
The gross margin method of estimating ending
inventory is based on the COGS model.
+
=
–
=
Beginning inventory
Purchases
Goods available for sale
Ending inventory
Cost of goods sold
Estimating Inventory
Rearranging ending inventory and cost of
goods sold makes the model useful for
estimating ending inventory.
+
=
–
=
Beginning inventory
Purchases
Goods available for sale
Cost of goods sold
Ending inventory
Estimating Inventory
Beginning inventory
$18,000
Purchases
72,000
Cost of goods available for sale
90,000
Cost of goods sold:
Net sales revenue
$100,000
Less estimated gross margin of 40.3% – 40,300
Estimated cost of goods sold
59,700
Estimated cost of ending inventory
$30,300
6-
Effects of Inventory Errors
An error in the ending inventory
creates errors for cost of goods
sold and gross margin.
The current year’s ending inventory
is next year’s beginning inventory.
Effects of Inventory Errors
Period 1
Ending
Inventory
Overstated
by $5,000
Sales revenue
Cost of goods sold:
Beg. inventory
Purchases
Cost of goods
available for sale
Ending inventory
Cost of goods sold
Gross margin
Period 1
Beginning
Inventory
Overstated
by $5,000
Period 1
Correct
$100,000
$100,000
$100,000
$10,000
50,000
$15,000
50,000
$10,000
50,000
$60,000
(15,000)
45,000
$ 55,000
$65,000
(10,000)
55,000
45,000
$60,000
(10,000)
50,000
$ 50,000
Ethical Considerations
Managers of companies whose profits do not meet
shareholder expectations are sometimes tempted to
“cook the books” to increase reported income.
What are some possibilities?
1. Overstating ending inventory
2. Creating fictitious sales revenue